Financial Analysis Story from the Canadian Farm Business Management Council.
The three most important areas for analysis are liquidity, solvency and profitability.
Liquidity measures the farm's ability to meet short term obligations as they arise throughout the coming year.
It is determined by the amount of working capital that is available which considers the difference between current assets and current liabilities. The current ratio is current assets divided by current liabilities. The standard rule-of-thumb suggests that this ratio should be at least 1, although this depends very much on the quality of current assets and the type of farm you have. Quality of assets refers to the amount of confidence you have that the current asset in question will be easily converted to cash. For example if inventory consists of feeder hogs almost ready for market you would have a higher level of confidence of your estimated value being realized than if your inventory consisted of two year old corn seed. Turnover of inventory is also important. For example a cow-calf operation would need a higher level of working capital than a dairy farm because of the longer time needed to realize sales on a beef farm.
Solvency measures the ability of the farm to meet its financial obligations in the long-term.
It is determined by comparing the level of total debt (amount of loans outstanding) with the level of equity (amount of investment by the owners). The standard rule-of-thumb is that debt should not be any more than two or three times the amount of equity. Typically the debt/equity ratio is much higher than this during start-up of a farm business but it is important to be able to demonstrate that sufficient cash flow exists to cover obligations and that the ratio is reducing over time.
Profitability measures the financial success of the business over time.
Of course, net income is the most obvious indicator but remember you have also likely invested some of your own money into the farm. You had other options for using that money to earn income, even if they were investing in mutual funds. Therefore, you should expect the farm business to provide you with a return on that investment too. The return on investment is calculated by dividing net income by your equity and multiplying by 100 per cent. This result should be compared with other opportunities you might have had to invest - adjusted for risk. Many farmers subtract the value of their management and labour (i.e. what they might have made in salary if available to work for someone else) from net income before calculating return-on-investment to arrive at a truer measure.
[URL="http://www.farmcentre.com/english/articles/master_article.htm?id=56"] Click Here to find the rest of the information from the CFBMC site.[/URL]
The three most important areas for analysis are liquidity, solvency and profitability.
Liquidity measures the farm's ability to meet short term obligations as they arise throughout the coming year.
It is determined by the amount of working capital that is available which considers the difference between current assets and current liabilities. The current ratio is current assets divided by current liabilities. The standard rule-of-thumb suggests that this ratio should be at least 1, although this depends very much on the quality of current assets and the type of farm you have. Quality of assets refers to the amount of confidence you have that the current asset in question will be easily converted to cash. For example if inventory consists of feeder hogs almost ready for market you would have a higher level of confidence of your estimated value being realized than if your inventory consisted of two year old corn seed. Turnover of inventory is also important. For example a cow-calf operation would need a higher level of working capital than a dairy farm because of the longer time needed to realize sales on a beef farm.
Solvency measures the ability of the farm to meet its financial obligations in the long-term.
It is determined by comparing the level of total debt (amount of loans outstanding) with the level of equity (amount of investment by the owners). The standard rule-of-thumb is that debt should not be any more than two or three times the amount of equity. Typically the debt/equity ratio is much higher than this during start-up of a farm business but it is important to be able to demonstrate that sufficient cash flow exists to cover obligations and that the ratio is reducing over time.
Profitability measures the financial success of the business over time.
Of course, net income is the most obvious indicator but remember you have also likely invested some of your own money into the farm. You had other options for using that money to earn income, even if they were investing in mutual funds. Therefore, you should expect the farm business to provide you with a return on that investment too. The return on investment is calculated by dividing net income by your equity and multiplying by 100 per cent. This result should be compared with other opportunities you might have had to invest - adjusted for risk. Many farmers subtract the value of their management and labour (i.e. what they might have made in salary if available to work for someone else) from net income before calculating return-on-investment to arrive at a truer measure.
[URL="http://www.farmcentre.com/english/articles/master_article.htm?id=56"] Click Here to find the rest of the information from the CFBMC site.[/URL]